Page 384 - THE MARKET WHISPERER

380 PART 11 - Risk Management

There is no stock exchange in the world that approaches the volume
of activity on Wall Street. On the London Stock Exchange, some 200 high-
volume stocks are traded. On Wall Street, some 10,000 are traded, of which
about 1500 show high volumes of more than one million shares per day.
Large volumes allow you to buy a stock at the click of the mouse, and no
less important, sell it in one click too. Low volume stocks usually have low
supply and demand, and the spread between bid and ask prices is likely
to be large. This means that you cannot enter and exit such low volume
stocks at any price: for example, when you want to sell, you may discover
that the closest lone buyer is several percentages below the last traded
price. Selling at that price means you will need to absorb heavy losses. You
can always try placing a limit order at a high price, but that means waiting
patiently for a buyer who may never show! You will encounter the same
problem in reverse if you want to buy a stock, or worse, if you want to
cover a short (in other words, buy) only to discover that the closest seller
is far above the stock’s last traded price.

Large volume stocks usually have small spreads and high liquidity. This
means you can use automatic orders to realize profits or losses and rely
on the computer to provide you with fast, effective executions as close as
possible to your chosen entry or exit point.

Several stop orders can be applied, the most familiar and important
being a defensive order known as a stop loss, which we discussed in
the section detailing trading platform orders. In this chapter, we will
understand their significance and how to use them.

Fundamental Risks

Every occupation carries its inherent risks. The athlete’s risk is a physical
injury; the surgeon’s risk is human error. Every profession is a world unto
itself, which makes it difficult to comprehend the risks until we dive deep
into that profession.

An athlete’s risks or those of a surgeon can be estimated, and therefore
they can be insured. Athletes insure themselves against injury, doctors are
covered by medical malpractice insurance, but no company in the world
will agree to insure a stock trader’s accounts. Insurance companies employ
professionals to calculate and manage risk. Since insurance companies will
not insure us, it is up to us to manage our risks. We cannot do that unless
we understand just what the risks are.